Much of the discussion around European Central Bank president Mario Draghi’s speech at the recent Economic Symposium at Jackson Hole has centered on the extent to which it was – or wasn’t – dovish. I think it was undeniably dovish but dovish within the harsh reality that there is only so much monetary policy can do. I think the speech is better described as an important “call to action” for a helping hand from fiscal policy and structural reform.
Since the Global Financial Crisis, and with
respect to the Euro zone the sovereign debt crisis also, I’ve made a number of
observations from time to time about the challenges of raising potential growth
rates that were damaged through the Great Recession. Foremost amongst those observations is the
fact (yes, fact) that improving potential growth is predominantly a structural
issue. The role for monetary policy is
to support demand and, where necessary buy time for the more important
structural reforms to be implemented.
The challenges in the Euro zone are unique
and more problematic to the extent that that necessary improvement in external
competitiveness in many countries, notably “the periphery” has been constrained
by a fixed exchange rate. That means the
adjustment has had to come via wages and employment. High rates of youth unemployment in many Euro
zone economies will ultimately prove to be one of the biggest social crises of
our time. Melodramatic? I don’t think so.
Progress has been made in reducing large
structural budget deficits but at considerable economic cost. Debt
to GDP ratios have a numerator and a denominator. Harsh front –loaded austerity measures have
thus far done more to damage the denominator than improve the numerator! Finance sector deleveraging has, and will
continue to constrain credit growth. Of
the measures announced in June by the ECB the TLTRO is most likely to have an
impact on credit growth although greater supply of credit does not itself
All that said there are a number of worthy
suggestions in Draghi’s speech. Firstly,
he believes “it would be helpful for the overall stance of policy if fiscal
policy could play a greater role alongside monetary policy”. He acknowledges the constraint that
levels of government spending and taxation in the euro zone are already amongst
the highest in the world. A while be also believes it would be self-defeating to break the rules
of the Stability and Growth Pact, he states the existing flexibility within
the rules could be used to better address the weak recovery and to make room
for the cost of needed structural reform.
Couldn’t agree more.
Secondly Draghi states “No amount of fiscal
or monetary accommodation, however, can compensate for the necessary structural
reforms in the Euro area.” Couldn’t
agree more (2). He believes that the reform agenda should span labour markets,
product markets and actions to improve the business environment.
He goes on to highlight two areas of labour
market reform he sees as priorities - policies that allow workers to redeploy
quickly to new jobs and raise the skill intensity of the workforce. You guessed it: Couldn’t agree more (3).
This was an important speech, well beyond its
implications for monetary policy. I
still think economic conditions will eventually see the ECB implement a more fulsome program of
asset purchases. But, again, all that will
do is buy time for the more important growth enhancing work to be done. Without that the Euro zone appears destined
for a very long period of very low growth.
Call it secular stagnation if you like.